Enterprise Value (EV) to EBITDA
- Enterprise Value (EV) = the total market value (MV) of the firm.
EV = MV of debt + MV preferred equity + MV common equity - Cash and investments
Cash and investments are netted out because these items reduce the net cost of purchasing the company.
- Enterprise value is a commonly used valuation perspective in M&A and investment banking transaction analysis.
- EBITDA = earnings before interest, taxes, depreciation and amortization
EBITDA = Net Income + Taxes + Interest Expense + Depreciation + Amortization
EBITDA is commonly used to approximate operational cash flows that are available to suppliers of debt and equity capital
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EV/EBITDA ratio is done on a total and not per share basis as it reflects value for all suppliers of capital.
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Positives of EV/EBITDA
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Can be used when comparing firms with different degrees of financial leverage because the P/E ratio reflects value after interest has been paid.
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The ratio will help make companies with high, but varying degrees of depreciation and amortization more comparable.
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EBITDA is less likely to be negative than earnings.
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Negatives of EV/EBITDA
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EBITDA can overstate operational cash flows in instances where working capital is growing.
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EBITDA will not reflect variances in revenue recognition practices across companies, and this impacts cash flow from operations.
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EBITDA is not as suitable for total firm valuation as Free Cash Flow to the Firm.
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Justifiable EV/EBITDA ratio: as FCFF rises, the multiple will increase; as WACC rises, the multiple will decrease.